Maybe it's the case, but I'd like to hear from others, that some misunderstandings about dividends we observe here stem from a commitment to spend only the portfolio's return.

Dividends clearly are return, and if paid they're positive. They're never negative. Investors don't have to send the corporation a check. Price changes are also return, but they may be in either direction. Of course participants in the market know the difference between buying a share of stock plus ten dollars one day, and buying the very same share but without the ten dollars the next day. They will not pay as much for stock + $0 as for stock + $10. That's why the price goes down by the amount of the dividend, although other market movements the day after the ex-dividend date may make it hard to see.

As an illustration, how much should I bid at auction for a box with a used iPhone in it? How much for the very same box with the very same used iPhone if everybody knows there's also a ten dollar bill in the box?

It is true, and only fair but I think sometimes confusing, that stock exchanges adjust limit orders by the amount of the dividend for those investors who leave them open overnight. Others might cancel their unfilled limit orders at the end of trade, and place new ones the next business day. The exchange does not set prices. It matches buyers and sellers. We call the most recent transacted-at price the current market price. Those who mark to market mark to that. I wrote a longer post which in the middle section discusses market mechanics.

We here on this forum have what I see as an unfortunate tendency to say words to the effect of total return includes both dividends and capital gains, without pointing out the former may decrease and the latter may be negative for years on end.

Sustainable withdrawal rate studies include the possibility of spending the portfolio down to zero after a specified number of years. Is that the misunderstanding?

Is my suspicion correct, that some of the resistance to the idea of total return investing stems from a commitment to only spend return, but then only pay attention to the always positive, or at least never negative, portion?

Let's pay attention to the total portion, positive and negative.
Imo, those only counting on dividends for their cash flow are guilty of defective accounting practices.
Using total return is clearly superior, since it is the investor deciding how much to withdraw (and when) and not a company's board, which has no idea whether I want to buy a new car, or go on a lavish vacation.

This is a good question. In any case trying to figure out why the topic appears and reappears like an addiction seems to defy thinking.

My own theory is that somewhere there is a mistaken perception that spending dividends is safe and selling shares is not safe. I think that is an easy to adopt mistaken perception for a number of reasons:

1. At least today when interest rates are low and stock dividends are historically low at about 2% compared to maybe 4% historically, spending only dividends really is safe. The reason is not because they are dividends but because the result is very low rates of withdrawal. You could hardly go wrong. Even taking a higher withdrawal rate it is not wrong that owning all stocks and arranging to spend even 4% or 5% will work far more often than it won't. To show for sure that this is true requires examining how a portfolio with a return and withdrawals would actually progress. The data shows that how much of the return is from dividends makes little or no difference, but a lot of work using correct math is required to get to the full picture.

2. I think the more powerful incentive is observing in the short run that dividends are not very volatile and seem to be reliable causes a psychology of grasping the obvious and not thinking beyond it.

3. I think many, at least inexperienced investors, are still locked into a savings account pays interest model of investing wherein one saves principal and the account rewards by paying out interest that does not "invade" the principal. A problem occurs when the model changes from owning consols that pay the same payout forever to owning stocks that fluctuate a lot up and down in value and can even disappear altogether.

4. In many case there is a simple absence of numeracy in which simple arithmetic facts are not recognized and the implications not appreciated.

5. Some posters are simply ignorant of the definition and properties of investment return and fall afoul of the "dividends are free money" fallacy. Sometimes this is hidden in a less obvious stream of discussion.

Our retirement income streams will include rents, royalties and dividends. We like income streams and there is no misunderstanding. Sure, we can and will sell shares to fund retirement as well. I see no problem with appreciating dividends as part of a total return strategy.

I think the misunderstanding comes from people here who think anyone who doesn't hold their nose when cashing a dividend check is either misguided or daft.

goingup wrote:Our retirement income streams will include rents, royalties and dividends. We like income streams and there is no misunderstanding. Sure, we can and will sell shares to fund retirement as well. I see no problem with appreciating dividends as part of a total return strategy.

I agree with that. The debates arise when someone believes that the only way to obtain income is by cashing a dividend check or when someone is proposing a version of what in the end is a dividends are free money fallacy. The harm would be that a person might not be adopting the easiest to manage and most useful financial plan or may actually be doing something that isn't wise.

I think the misunderstanding comes from people here who think anyone who doesn't hold their nose when cashing a dividend check is either misguided or daft.

I don't think anyone here thinks that. The comments are almost entirely reactions to things that are real misunderstandings. I am a big poster on these threads and I cash all my dividend checks and use the money for income.

Being a fairly new member of Bogleheads Forum I' am amazed at the
passion of the dividend discussion.

In my mind it's the type of stocks that we like to invest in.
Would you rather own "Gold" that pays no dividend but
is really shiny? Or "Microsoft" that pays a dividend?
Both are good investments...

For a long term buy & hold investor like me that is
sitting in the weeds for years & years to come, I would rather
invest in a dividend stock. At least it is paying me to wait.
I gather up more shares each quarter that helps it compound
out faster, (dividends on dividends on dividends = compounding out).

snarlyjack wrote:Being a fairly new member of Bogleheads Forum I' am amazed at the
passion of the dividend discussion.

In my mind it's the type of stocks that we like to invest in.
Would you rather own "Gold" that pays no dividend but
is really shiny? Or "Microsoft" that pays a dividend?
Both are good investments...

For a long term buy & hold investor like me that is
sitting in the weeds for years & years to come, I would rather
invest in a dividend stock. At least it is paying me to wait.
I gather up more shares each quarter that helps it compound
out faster, (dividends on dividends on dividends = compounding out).

Your dividends are only buying additional shares in the amount that the share price was reduced by the payment of a dividend - so it's a wash. I think this was kind of the point of the original post, no?

When I started investing in VHDYX (a couple years ago) the
price was about $25.00 per share. Today the price per
share is about $31.00 .

In the last few years I have accumulated a lot more shares.
Some by dollar cost averaging each month, some by
dividend payments reinvested each quarter.

All I know, is I have substantially more shares & money today
than I started with. In my mind I' am a happy camper!
I' am smiling all the way to the bank...Let's hope it keeps
going this way. If not, I'll buy & receive even more shares at a
even better price.

I think misunderstandings stem in large part from the nature of disconnected, absentee ownership, exacerbated by the mutual fund layer between investor and company, obscuring the flow of cash and capital into and out of the companies in which we are stakeholders. It's a black box for many investors.

On the other hand, perhaps associations are made with small businesses where sometimes the only practical way to get cash quickly is to pay a dividend or take a withdrawal.

"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

saltycaper wrote:I think misunderstandings stem in large part from the nature of disconnected, absentee ownership, exacerbated by the mutual fund layer between investor and company, obscuring the flow of cash and capital into and out of the companies in which we are stakeholders. It's a black box for many investors.

On the other hand, perhaps associations are made with small businesses where sometimes the only practical way to get cash quickly is to pay a dividend or take a withdrawal.

The mutual fund abstraction layer should make it easier, not harder: Dividends are plowed into fund until distribution; NAV adjusts on distribution; reinvestment restores total dollars invested. Why anyone chooses a dividend strategy after realizing this is beyond me.

edit: one of my long-standing to-do list tasks is to determine what portion of SPY's 20% lag in total return since 1993 compared to VFIAX is due to a lack of reinvestment of dividends. This might clear up confusion for some people.

"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

When I sell a stock or stock fund with a loss I get a deduction. When I sell a stock or a stock fund with a gain I only pay taxes on the gain. So homemade dividends increase my wealth over company paid dividend via lower taxes.

If I have $1000 in dividends I pay $200 in taxes at the 20% rate. If I sell $1000 of stock with a capital loss I get to deduct the loss from a capital gain or possibly ordinary income.

If I sell $1000 stock with a $500 long term capital gain I only pay taxes on the $500 of gain or $100 in taxes at the 20% LT capital gain rate.

I can't get away from dividends completely so I spend them when I get them in retirement.

I see how some people with self control issues are better off spending only dividends. They might deplete their portfolios quickly if they started to make homemade dividends.

triceratop wrote:
The mutual fund abstraction layer should make it easier, not harder: Dividends are plowed into fund until distribution; NAV adjusts on distribution; reinvestment restores total dollars invested. Why anyone chooses a dividend strategy after realizing this is beyond me.

In one way, yes, and those questions are dispatched with ease, but in another way, it's one more step between the cash coming off the company's balance sheet, no longer available for future investment by the company, and the cash showing up in the investor's account.

Then start the more contentious debates about what it means to own a publicly traded company that doesn't pay a dividend.

"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

Phineas J. Whoopee wrote:Is my suspicion correct, that some of the resistance to the idea of total return investing stems from a commitment to only spend return, but then only pay attention to the always positive, or at least never negative, portion?

Part of the resistance to the total-return approach may just be the long shadow of history (“Never spend the principal!”). Prior to about 1980, one couldn’t even invest for total return in any practical way. Mutual funds were rare, stock were expensive to sell (especially in odd lots), and retirement portfolios were constructed around high-paying, widows-and-orphans stocks.

Personally, as a young person, no one ever told me that it was wise to spend only portfolio dividends and interest — nor do I recall ever reading this advice in a book — but it was certainly a strong, unconscious aspect of financial lore that I absorbed from somewhere growing up in America.

I think [stuff --admin LadyGeek] like this matters. An investor would have to be blind and deaf not to be exposed to a lot of it.

P.S. By the way... has Buffett "grown his wealth consistently?"

("Consistently" is a red flag to me. When I see it, I get ready to discount whatever comes next. "Consistently" usually means "inconsistently, but we choose to ignore the bad years because they shouldn't count.")

Last edited by nisiprius on Thu Jul 06, 2017 4:32 pm, edited 2 times in total.

Phineas J. Whoopee wrote:Is my suspicion correct, that some of the resistance to the idea of total return investing stems from a commitment to only spend return, but then only pay attention to the always positive, or at least never negative, portion?

Part of the resistance to the total-return approach may just be the long shadow of history (“Never spend the principal!”). Prior to about 1980, one couldn’t even invest for total return in any practical way. Mutual funds were rare, stock were expensive to sell (especially in odd lots), and retirement portfolios were constructed around high-paying, widows-and-orphans stocks.

Personally, as a young person, no one ever told me that it was wise to spend only portfolio dividends and interest — nor do I recall ever reading this advice in a book — but it was certainly a strong, unconscious aspect of financial lore that I absorbed from somewhere growing up in America.

This would appear to me to play a role. It is a message some people have heard somewhere. Also that idea can be enshrined in law when it comes to how trustees are required to determine payouts to beneficiaries.

Expanding on this it may also be that investor favor of stocks that pay dividends may also be partly tradition as decades ago obtaining income from a position was more difficult if there were not dividends.

Phineas J. Whoopee wrote:Is my suspicion correct, that some of the resistance to the idea of total return investing stems from a commitment to only spend return, but then only pay attention to the always positive, or at least never negative, portion?

Part of the resistance to the total-return approach may just be the long shadow of history (“Never spend the principal!”). Prior to about 1980, one couldn’t even invest for total return in any practical way. Mutual funds were rare, stock were expensive to sell (especially in odd lots), and retirement portfolios were constructed around high-paying, widows-and-orphans stocks.

Personally, as a young person, no one ever told me that it was wise to spend only portfolio dividends and interest — nor do I recall ever reading this advice in a book — but it was certainly a strong, unconscious aspect of financial lore that I absorbed from somewhere growing up in America.

This would appear to me to play a role. It is a message some people have heard somewhere. Also that idea can be enshrined in law when it comes to how trustees are required to determine payouts to beneficiaries.

Expanding on this it may also be that investor favor of stocks that pay dividends may also be partly tradition as decades ago obtaining income from a position was more difficult if there were not dividends.

I'm too young to actually be exposed to the lore, so everything I learned was from the 'correct' financial understanding that dividends are but one component of total return. However, I did read several of the old books (Graham and Dodd, as well as ``The Intelligent Investor'') so as a matter of history I can try to give a perspective.

With high transaction costs it makes sense that the most visible sign of a successful investment is an increasing stream of dividends. Imagine that one knows the capital invested, ignores the share price because one cannot sell without incurring transaction costs (and do what with the proceeds? More transaction costs), and direct dividends to future investment opportunities. It's not hard to see how the natural sign of a successful investment turns into more, into itself the determinant of successful investment. It's curious that this has persisted even with mutual funds and cheap, broad diversification, but philosophies die hard. Just my perspective on how it must have been to invest.

"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

Seems like we can file most of the "that's the way things used to be" and "that's what the marketing materials said" reasons under the general issue of investors accepting what their told without thinking critically and asking questions about why an approach is being recommended. Then there's the tendency of reluctance to change one's mind despite hearing evidence to the contrary. None of this sounds specific to investing though.

"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

I, alas, am no spring chicken. I remember a middle school teacher (one who never met an urban legend he didn't repeat to us as fact) saying the only value of a stock is its dividend stream. In high school the physics teacher told us the same thing. They didn't say so, perhaps they didn't know, but they were using the Dividend Discount Model.

They weren't using the concept of money in its unit of account sense, that's for sure, whether or not they had heard of it.

From time to time posters here express the same idea, despite the Modigliani-Miller Theorem being well known. Not everybody has to accept the theorem, but I think every serious person has to acknowledge its existence.

erishera wrote:What about the other side of this argument? The dividends are voted on by the board of directors which is supposed to have the investor's long term interests at heart.

Please, by all means, flesh out the details about the other side, as you see it, of this argument.
PJW

what I meant by the other side of the argument is that, in my view, some company's boards present the dividend payout as something superior to the total return. For example, they advertise their dividend history and growth going back decades as something special. At the same time, as I understand it, dividend payout is only good for the company/shareholders when there is no better (more profitable) use for the money than giving back to the shareholder. Can that be true over the decades of scheduled payouts. If total return is their duty, are they not falling into the same limited view of dividends being somehow superior part of the total return.

Here's another: Dividend-focused investors seek to have their cake and eat it too. Related to the "dividends are free money" fallacy, dividend-focused investors may be reluctant to sell shares to generate cash because they would be selling off part of their cash-generating machine. Since dividend yields haven't been as volatile as stock prices (at least, not at the extremes, I believe), the dividends seem more reliable than the price at which you can sell a share in the future, which makes the sale of shares hurt doubly so. Segue into the substitution of dividend stocks for bonds.

"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

snarlyjack wrote:When I started investing in VHDYX (a couple years ago) the
price was about $25.00 per share. Today the price per
share is about $31.00 .

In the last few years I have accumulated a lot more shares.
Some by dollar cost averaging each month, some by
dividend payments reinvested each quarter.

All I know, is I have substantially more shares & money today
than I started with. In my mind I' am a happy camper!
I' am smiling all the way to the bank...Let's hope it keeps
going this way. If not, I'll buy & receive even more shares at a
even better price.

This is part of the misunderstanding around dividends! If VHDYX companies did not distribute a dividend, then theoretically you would have fewer shares but the price per share would be worth more than $31.00. Thus, the amount of wealth you have would be no different than what you have now. Yet you still seem to be attributing some of the growth in your investments to dividends when they are in fact immaterial to the amount of money you have today!* Sigh...

SAM

*I'm ignoring a few mathematical rough edges here, but the broader point is unchanged.

I think some people use dividends as an easy (albeit inaccurate) measuring stick for judging performance. Even if you aren't a sophisticated investor, it's easy to understand that something paying 5% on the dollar is better than something paying 2%.

Taken to extremes, this leads to a certain type of overconfident investor chasing "fat yields," and thinking they beat the system by loading up on high-yield REITs or MLPs.

Simplegift wrote:Personally, as a young person, no one ever told me that it was wise to spend only portfolio dividends and interest — nor do I recall ever reading this advice in a book — but it was certainly a strong, unconscious aspect of financial lore that I absorbed from somewhere growing up in America.

I think this is true for me as well.

I believed this common misunderstanding about dividends for most of my investing life. Thankfully, I found the Bogleheads forum a couple years ago and learned about total return.

Like many people, I assumed that dividends were something like interest payments. The idea that taking dividends is fundamentally not different from selling shares feels deeply counterintuitive. It took quite a bit of reading to fully unlearn what I had previously believed was true.

Ragnoth wrote:I think some people use dividends as an easy (albeit inaccurate) measuring stick for judging performance. Even if you aren't a sophisticated investor, it's easy to understand that something paying 5% on the dollar is better than something paying 2%.

Except that it is not true. First of all, some companies do not pay dividends as policy although they could, Berkshire immediately comes to mind. Secondly, dividend yield is calculated with respect to the stock price: a declining company could appear as paying out the best dividends of all.

I mean, "higher dividend, better asset" is not even true for bonds, imagine for stocks!

Good discussion. Whoever planted this dividend seed was quite a farmer; it's a stalk that won't fall. John Burr Williams may get some of the credit/blame from his Depression-era "Theory of Investment Value." Popular book in its day and has actually been celebrated as a good read by Warren Buffet who has paid a dividend only once at Berkshire. Saving everyone from an Amazon buy: A stock is worth only the discounted value of its future dividends. Not earnings.

I don't know that Williams invented the "bird in hand" theory of dividends, but he did have a poem:

A cow for her milk

A hen for her eggs,

And a stock, by heck,

For her dividends.

An orchard for fruit,

Bees for their honey,

And stocks, besides,

For their dividends.

I like the thought that it's somehow connected to clipping coupons from bonds. Or it's some kind of cognitive dissonance. Lots of annuity holders don't seem to know they are just getting their own money back with some interest attached.

Definitely agree that before commissions were deregulated it was highway robbery to sell a stock to raise a little capital. In the early days of Fidelity I can remember paying $49.95 to trade on their "cheaper" phone system; lots more if you called a rep. A ticket at Dean Witter was several times higher. Fidelity used to offer an option on its stock funds to "get a monthly check." Haven't even checked to see if that is still offered. Might help people with the dividend dilemma.

The other explanation I hear a lot is getting the dividend eliminates/reduces the "agency risk," as in "they will waste if it isn't paid out to me." Kind of a "free short" on corporate management. Same idea with why closed-end funds sell at a discount: easy way to short the manager for poor performance. I've never had much luck explaining to some investors what a buyback does for them.

Analysts who should know better promote the devil out of the theory that dividend stocks outperform. That ranges from Tweedy Browne (Graham and Buffet connections) to Morningstar which had a very popular dividend newsletter at least until Josh Peters departed to Oppenheimer to run a div. fund.

One other thought is that it all may be a hangover from the Depression. Stock dividends out-yielded bonds until 1958. Ben Graham actually had a cautionary note to investors that this might signal an over-valued market since post-Depression the market had favored dividends because stocks were so risky. I don't recall the message of the 1950's campaigns by the NYSE and brokerages to "own a share of America," but maybe they promoted dividends as well.

This is my simple way of looking at it. Say I have an IRA containing a mutual fund with dividend-paying stocks and I am taking RMDs. Twice a year Vanguard sells enough of that fund to meet my RMD requirement. I hope that over time the value of that fund will increase more than the RMDs decrease it.I don't really care if that increase is due to dividends that are used to buy more shares or appreciation of the underlying shares.

Echoing several previous responses, I agree that a lot of it boils down to the reductionist thinking that shares purchased are "principal", and the self-imposed 11th Commandment that goes along with it: Thou Shalt Not Touch Principal.

Many fallacious corollaries are within easy reach of it, such as:

* Dividends are precisely the amounts that are "safe" to spend.
(Never mind that this results in variable income, or working longer than necessary, or unnecessary downgrading of lifestyle.)

It may also be one of the significant factors behind the "Annuity Puzzle". You'd think folks obsessed over the "safety" of dividends would appreciate the possibility of much larger and stable retirement income streams via SPIAs, but purchasing such streams involves violating the 11th Commandment.

I also see analogous struggles in the recurrent threads asking for the "right way" to take RMDs, including when to do so and what funds to do it from.

While I don't think any of the choices involved in how one satisfies the RMD rules matter much at all (apologies to the spreadsheet brigade), I believe it is uncomfortable for some folks for exactly the same reason--it requires dipping into "principal". Indeed, some seem to need to be reminded that one is not required to spend distributions from one's IRA.

One would hope that turning 70.5 and being forced to take distributions in amounts that don't match dividends might be an opportunity to get beyond the 11th Commandment, but it doesn't always seem to work out that way.

I pretty much only spend dividends in my taxable accounts because I don't usually need any "homemade" dividends to cover my expenses most of the time. The dividends are already taxable. The taxation is less than unqualified dividends that mostly are in my Roth. I don't have any choice but to have dividends as my favorite fund is the Total Stock Market TSM.

Only spending returns makes sense if you are concerned about a legacy, have no need to spend more or are concerned about running out of funds prematurely because of potential self control spending issues. It is okay to think this way as long as you are not kidding yourself that dividends are different than principal. As in an earlier post I stated that in taxable accounts the taxation of capital gains is lower than taxes on dividends. If you compare $1k in dividends you are taxed on all of it. If you have a $1k withdrawal of a "homemade" dividend you are only taxed on the capital gain.

"Widows and orphans" might benefit from only spending returns as the assumption is they are naïve about finances and are at risk for lacking self control and might otherwise spend too much principal. A trust fund for an incompetent or spendthrift individual might be set up to to only allow spending of returns.

snarlyjack wrote:
When I started investing in VHDYX (a couple years ago) the price was about $25.00 per share. Today the price per share is about $31.00 .

All I know, is I have substantially more shares & money today than I started with. In my mind I' am a happy camper!

As another poster has suggested, I think you've inadvertently backed up Phineas's point about dividend misunderstanding. VHDYX was trading at $22.77 exactly 4 years ago (07-08-2013). It's trading at $30.95 today. Yeah, the NAV went up (by 8.48% CAGR just looking at the NAV), and yes you have more shares then when you started. But is this because of the dividends? NO.

Ok...So I'm a young guy (23 years old). My investing time is
age 100 - age 23 = 77 years. In that time frame I could place
my money onto any fund & do great... But what I 'am interested in
is "financial security". The markets are going to go up & down.
Boom times & bust times...war & peace. I want to make sure
that I have a income coming in no matter what happens. Without
liquidating off the portfolio. In other words, don't kill the goose that
lay's the golden eggs. I realize it's all psychology but I feel peace
of mind with money coming in quarterly. I refuse to starve in the streets...
I can stick with my plan...through thick & thin...for years to come.
I' m not going to get thrown out (faked out) of the markets. I can
hold my position for 77 more years & profit from it... with a income
to boot.

snarlyjack wrote:
I can hold my position for 77 more years & profit from it... with a income to boot.

If you're reinvesting the dividends during the accumulation phase, then they serve no purpose (TSM has higher return with lower dividend) and if in taxable are actually hurting return. If you want the dividends to provide income if you lose your job at some point in the next 30 years, then most people would advise that an emergency fund is the preferred option. Finally, in withdrawal phase, they can definitely serve a purpose as part of what you need to live on. But you're correct in that most of this is psychology and not economics.

This thread sparked a thought: do "total return" charts take into account taxes on the dividends? It seems that it might be best to hold dividend stocks in tax advantaged accounts to avoid tax on dividends.

It's our tax code (in a taxable account). It would be nice
to have the money in TSM then be able to switch it to a
income fund without paying capital gains tax. (Most of my
money was due to life insurance proceeds, so it's all in a
taxable account).

I feel like I' am forced to pick the correct/best
fund right from the beginning of my investment career.
Every time you switch funds for whatever reason (oops,
wrong fund company, wrong fund, redo my AA, etc) your
taxed. Not to mention your positioning (price you bought
in at). While I like the TSM fund the dividend level is just
to low for my wants & needs.

Yes, I could invest in a small stock fund or EM fund but when it's
all said & done you have to sell part of the fund for income. With my
time frame I think that defeats the purpose of the whole thing.
I have 62 years - 23 years = might as well say 40 years before I can retire.
I think in that time frame I'll have lot's of money (just by compounding growth).
So I'm not worried about money...I'm more worried about income. The perfect
plan would be good growth & income. It's kind of like the richest guy
in the cemetery...what's the point in that?

Thank you for your help Tropik Thunder...I appreciate all your analysis
& suggestions!

Afty wrote:This thread sparked a thought: do "total return" charts take into account taxes on the dividends? It seems that it might be best to hold dividend stocks in tax advantaged accounts to avoid tax on dividends.